Invest Like It's the Great Depression Again


In the middle of the Great Depression, value pioneers Benjamin Graham and David Dodd launched an investing revolution with their now-classic book Security Analysis. In it, they laid out the framework for value investing, a straightforward strategy that has stood the test of time and made several of its practitioners (such as Warren Buffett) billionaires.

While times, technology, and techniques have changed somewhat since their book was originally published in the 1930s, the fundamental foundation remains the same. At its core, value investing is all about figuring out what a company is really worth and only buying shares when the market serves up a price below that level. It's a simple concept, and in times like these when the economy and market are certainly not firing on all cylinders, it's one worth embracing again.

Why value still works
As Graham himself pointed out, especially in the short term, the market is more of a "voting machine" than a "weighing machine." Popularity and sentiment -- not true business worth -- drive the daily fluctuations in stock prices. That helps explain why 84% of the companies listed on the New York Stock Exchange saw their shares fall during Friday's sell-off.

Sure, the lousy jobs report that started the selling was bad news, but did it really mean that nearly all companies were suddenly worth significantly less? In reality, as part of that indiscriminate sell-off, the market threw out some strong companies along with the ones that probably needed to fall. Indeed, on any given day, the market will throw out some companies that don't deserve to be thrown out and will reward some that shouldn't be rewarded.

As strange as this behavior may seem in this age of instant communication and incredibly powerful computing, the reality remains that nobody has yet learned how to accurately predict the future. And as long as a company's true value depends on how it performs in that undetermined future, there will be room for both overly fearful and overly optimistic projections to influence a stock's price.

What you can do about it
While there is still investing risk from that uncertain future, the valuation concepts that Graham and Dodd provided nearly a century ago are just as valuable today as they were then. One of the easiest of their techniques is to look for companies trading close to their net tangible asset values. In essence, by buying a stock like that, you're paying for its physical assets like buildings and cash, and any business results like profit and growth largely come along for the ride.

In ordinary times, bargains like that are either few and far between or generally such damaged companies that they're rightly priced for the likelihood that they'll actually destroy shareholder value. These days, though, the market has turned so negative on the economy's prospects that it's getting possible to find the proverbial babies thrown out with the bathwater.

For instance, Toyota (NYS: TM) currently trades at about 90% of its net tangible book value, while its business is actively recovering in the wake of its natural-disaster-filled 2011. Likewise, the flack over JPMorgan's (NYS: JPM) multibillion-dollar trading loss has put its shares up for sale at less than 94% of its tangible book value. But with JPMorgan still projected to earn money in the quarter despite that loss, it's evident the bank is strong enough to recover and legitimately profit over time.

Of course, not every company that looks cheap really is cheap. Smartphone pioneer Research In Motion (NAS: RIMM) stands out as an example of a potential value trap. It is trading below its net tangible asset value, but it's also actively losing money. If Research In Motion can't turn its business around, which would require the daunting task of out-innovating Apple (NAS: AAPL) in the smartphone arena, then continued projected losses can quickly wipe out those net assets.

Go bargain hunting
With one eye on a company's balance sheet and the other on its legitimate business prospects, you can ferret out real bargains in today's volatile market. And with all the turmoil around the globe adding to America's economic struggles likely to provide even more short-term pain, it's certainly comforting to know that this particular value-oriented strategy got its start during the Great Depression and created billions in wealth for its most successful adherents.

At the time thisarticle was published At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article, but that may change once the Fool's disclosure policy allows. Click here to see Chuck's holdings and a short bio.The Motley Fool owns shares of JPMorgan Chase and Apple. Motley Fool newsletter services have recommended buying shares of and creating a bull call spread position in Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.